Transcript

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1TOPIC 10: FINANCIAL STATEMENT ANALYSIS

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2IntroductionInterpretation is when users evaluate financial information to make judgementsIt is the key to any in-depth understanding of an organisation’s performance.Basically, the users evaluate an organisation’s performance and financial position using the information from INCOME STATEMENT and BALANCE SHEET.The value of the analysis is depends on the value of the financial statements.

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3Techniques (types) of analysis:1.HorizontalAnalysis Comparing key figures in financial statementEvaluates a series of financial statement over a period of time.2. Vertical AnalysisEvaluates financial statement by expressing each item in a financial statement as a percent of the base amount (key figure)Key-figure (such as sales in IS and total assets on BS) are set to 100%Other items are then expressed as percentage of 100

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4Techniques (types) of analysis: (cont.)3. Trend analysisSimilar to horizontal analysis, except that the first set of account in the series is given a base of 1004. Ratio AnalysisIt expresses the relationship among selected items of financial statement data.

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5Horizontal AnalysisIt’s an analysis of the percentage increases and decreases of related items in comparative financial statements.What is horizontal analysis?

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32LIQUIDITY RATIOIt measure the short term ability of the organisation to pay debt and to meet unexpected need for cash.i. Current RatioTo measure the ability of current asset that the company have to pay back the short term debt. = Current Asset Current Liability

This ratio indicates whether current liabilities could be paid without having to sell the inventory

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This ratio is useful for companies which cannot convert inventory into cash quickly if necessary.

34Cont….This ratio indicates whether the business has enough short-term assets to cover its short-term liabilities.A ratio above 1 indicates that working capital is positive (Current assets exceed current liabilities)A ratio below 1 indicates that working capital is negative.Many large companies regularly operate with current ratio closer to 1 and 2

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35Generally the higher the ratio, the greater the financial stability and the lower the risk for both creditors and owners.However, the ratio should not be too high because that may indicate that the business is not reinvesting in long-term assets to maintain future productivity.High current ratio can actually indicate problems if inventories are getting larger than they should be or collections of receivables are slowing down.

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36EFFICIENCY RATIODebtors turnoverMeasures how many times it takes customers to payCredit sales Average debtors

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37EFFICIENCY RATIO1. Debtors collection periodMeasures how long it takes customers to pay= Average debtors x 365 days OR365 days Credit salesdebtors turnoverThis ratio indicates how many days it takes, on average to collect a day’s sale revenue.The quicker a business collects and bank the money, the better it is to the companyLarge numbers of days is a negative signal, raising questions about the company’s policies of granting credit such as;Unrestricted credit policiesLonger credit limitCollection attempts is not very strength

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38Efficiency Ratio3. Stock turnover ratiomeasures how quickly stock moves through businessThis ratio means that the average length of time that the stocks are held before being sold.= Cost of goods sold Average stockIt can also be calculated in days= Average stock x 365 days OR 365 days Cost of goods sold stock turnover

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49Limitations of the Accounting InformationEstimatesThe financial statement contains numerous estimates. Eg. Provision for doubtful debt, depreciation and contingent loss.Cost The traditional financial statements are based on historical cost, it is not adjusted for price-level change. Eg. Inflation affects the sales growth.Alternative Accounting Method A comparison may be misleading as different companies use different accounting method. Eg. FIFO and LIFO.Diversification of firms This diversification of activities of companies limit the usefulness of financial analysis. (no specific industry).